Is Buying Bonds Really a Good Idea?

The WSJ’s Brett Arends has learned his lessons this year, and shares them with us, including these ones:

4.Invest more, not less. Is that a guffaw from the peanut gallery? I don’t blame you. Your savings just fell 40% or more. But higher risk and lower returns means you need to invest more to reach your goals.

6. Your grandma was right after all. A penny saved really is a penny earned. Debt really is dangerous. And an economy where it’s easier to borrow $10,000 on a credit card than find a working electrician is heading for trouble.

8. Own plenty of bonds. Yes, they’re less exciting than stocks. Turns out, that’s the point. There’s little use keeping everything in stocks "for the long run" if they kill before you get there.

I do wish that he’d listened a bit more to his grandma. A penny saved is a penny saved; a penny invested is a penny risked. The best way to reach your goals is to save more, and to adjust your goals — not to put ever more money at risk in a desperate get-there-or-bust move.

As for the bonds, this could turn out to be a really bad time to move into fixed income — possibly the worst in living memory. Two things we know for sure: interest rates are incredibly low right now, and recovery values given default have also never been lower. A third thing we can be pretty sure about: the number of defaults is going to go up substantially before it starts coming down. Yes, spreads are quite wide, but only arbitrageurs care about spreads. Retail investors care about yields.

Put all that together, and you have a bond market where the downside is vastly greater than the upside. Yields can’t fall much further than they have already, and default rates can certainly rise. So why buy bonds? Stay in cash, and you get a very similar yield for much less risk.

Historically, bonds have been the safer alternative to stocks. I’m not sure that’s still the case. Stocks are certainly more volatile than bonds, but at least they have unlimited upside, and a couple of spectacular stock picks can make up for a lot of duds. In the bond market, however, a few big defaults can ruin an entire portfolio. So I’d treat bonds as being just as speculative as stocks. Speculative bonds are also known as "distressed", and in many ways we’re all distressed now. So if you want to be safe, my advice is to avoid fixed income, at least for the time being.